Dollar's bottom holds, but investors warily watch oil

LisaTwaronite

SAN FRANCISCO (MarketWatch) -- First, the good news: Even after Monday's sharp drop, the dollar remains off its 2008 lows against the yen and the euro.

But while the bottom appears to be holding for now, many are wondering how long that will be true, as the greenback faces the double whammy of massive fiscal outlays by the U.S. government, combined with a renewed surge in dollar-denominated commodities prices.

The dollar remains well off its 2008 low of 99.75 set in March, in the wake of the Bear Sterns sale. But it tumbled more than 2% against the yen Monday, buying 105.34 yen in late trading. See Currencies.

The euro gained more than 2% Monday to trade at $1.4791 late Monday, remaining well below $1.6038 set on July 15 - its highest level since its January 1999 debut.

As recently as Sept. 11, the European unit was trading as low as $1.3882, before the U.S. financial sector started to unravel. The government's proposed rescue plan was greeted with a sell-off on Wall Street Monday, and dramatic moves in currency and oil markets as well.

"Rather than stabilizing or calming the markets, the destruction of the U.S. balance sheet has triggered the largest drop in the U.S. dollar against the euro since its inception in 1999 and the largest single-day rise in oil prices since 1984," wrote Kathy Lien, director of currency research at GFT, in a note to clients Monday.

"As the U.S. fiscal position deteriorates, the only trade that has been benefiting is long commodities," she said.

Crude bolted to $130 a barrel as it scored its biggest daily gain in dollar terms since 1984, when it began trading on the New York Mercantile Exchange. October crude rose $16.37, or 15.7%, to close at $120.92 per barrel. See Futures Movers.

Oil's standard trading unit is dollars per barrel, so a move in one typically fuels an inverse move in the other. As the dollar loses value, so does the price of oil for investors holding other currencies - many of whom are looking for places to park funds amid the recent global upheaval.

But no one knows how long the boom will last, as the outlook for global oil demand is uncertain pending the success of the U.S. rescue plan and the impact of recent hurricanes on production and refinery activity in the Gulf of Mexico, analysts said. See Commodities Corner.

Unattractive to foreign investors

The proposed rescue plan would allow the government to buy the bad debt of U.S. financial institutions for the next two years. It gives the Treasury secretary authority to buy $700 billion in mortgage-related assets, and would raise the statutory limit on the national debt from $10.6 trillion to $11.3 trillion. See full story.

While a weaker dollar can help narrow the U.S. trade deficit by making America's exports more affordable abroad, it can also make funding those imbalances more difficult. The U.S. has to attract billions of dollars a day from foreign investors, and a weakening currency makes dollar-based assets less attractive.

"With the details of the plan yet to be hashed out, the one thing that is certain is that U.S. taxpayers will have to foot the bill, which is ultimately negative for the US economy. The U.S. is surrendering free-market capitalism which is very unattractive to foreign investors," said GFT's Lien.

"[D]iscipline and prudence requires respecting the price action and we recognize the genuine concerns about the trajectory of US fiscal policy," said Marc Chandler, head of global currency strategy for Brown Brothers Harriman.

But even in the face of Monday's dollar plunge, Chandler nonetheless remained hopeful that the effects of the plan will turn out to be positive.

"As was the case earlier in the crisis, we think that although the U.S. dollar gets punished in the short-term because of the bold and innovative approach by U.S. policy makers, the U.S. will be rewarded in the medium term for the same reason," he said.

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